Tuesday, July 10, 2007

Calculating the Performance of Your Portfolio

I have been investing in stocks for about 7 years. Until 2007, I have absolutely no idea what my rate of return was and whether I under/over performed the market.

Many of us (myself included) believe that we are better investors than we really are. We vividly recall the success of winning stock picks but somehow forget about the losers. In my case I like to think of all the money I made in PetroBras stock over the last few years. But what about the small fortune I lost trading gold futures in 2006? I almost never think about that – I have subconsciously blocked it from my memory. While it can be fun to live in a fantasy world, it is important to know the truth so that we can make smart decisions.

Why is it so hard to figure out my return? Because I’ve been continuously adding money to my brokerage accounts…. Sure my account is going up in size, but how much is a result of savings and how much from positive returns? I use Excel and the formulas below to easily track my portfolio returns. Now that everything is setup, it takes less than 5 minutes per month.

Monthly Return:

Each month I compute the time-weighted-return of my portfolio. This tells me the return of my portfolio for the month and takes into account any deposits or withdrawals:

Rate of Return = Change in Mkt Value / (Beg Bal + (Net Contributions * Factor of days in Month)

For example, if I contribute $1,000 into my account on the 20th day of June, I would multiply the contribution by .33 (10/30). This is done because the $1,000 contribution was only in the account for 1/3 of the days in June.

Calculating Compounded Monthly Return:

Use this formula to calculate the compounded monthly (or any period) return in your portfolio:

Return for the Year = (1 + R1)*(1 + R2)……(1 + R12) – 1

In the above formula, R1 = rate of return for January, R2 = rate of return for Feb, etc.

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